A plan to dodge tax liens runs aground.

McLEAN, VA–Alexandra Murnan wasn’t clear about paying taxes.  By 2001 there were multiple federal tax liens against her, totaling more than $100,000.

So when an uncle offered to give her a house in upscale McLean, Alexandra saw she would have a problem.  The tax liens were recorded in Fairfax County, and if she accepted a deed the liens would attach and the IRS might force a sale of the property to pay her tax bill.  What to do?

Alexandra consulted a lawyer, and based (perhaps only partly) on advice she created a trust to take title to the property.  Four days later, the uncle signed a deed conveying the property to Alexandra, as Trustee of the “Murnan Spring Hill Trust,” and the Trust took title subject to the uncle’s mortgage in the amount of $420,905.

The Trust subsequently borrowed from a mortgage lender to make improvements to the property.  Incident to these borrowings the Trust gave a deed to the lender to secure repayment.  When the Trust failed to make payments, the lender recorded the deed and became owner of the property.

In February 2003, the Trust negotiated to repurchase the property for $819,604.  The repurchase was financed by a new mortgage loan.  As part of this transaction, the Trust obtained an owners policy of title insurance in the amount of $1,450,000 from Stewart Title Guaranty Co.  Although Stewart Title was aware of the recorded tax liens, the title policy in favor of the Trust did not include a specific exception for them.

Within months the recent mortgage was also in default, so the Trust offered the property for sale.  In September 2003, the Trust contracted to sell the property to Krishna Tayal for $1,140,000.

But this time several title companies, including Stewart Title, required that the tax liens against Alexandra individually be paid, before they would issue a new owners policy to Tayal with coverage against them.  The liens now totaled almost $300,000.

The Trust made a claim under its title policy, but Stewart Title denied coverage.  Tayal canceled his purchase contract, and the Trust filed suit against Stewart Title for breach of the insurance contract.

A federal trial court ruled in favor of Stewart Title, and the Trust appealed.

The Fourth Circuit Court of Appeals affirmed the trial court, finding the liens against Alexandra individually would attach to this Trust property, because the Trust was revocable at the sole discretion of Alexandra, she had control of Trust assets (the house), and she was sole beneficiary of the Trust during her lifetime.  It follows that if the IRS should enforce its lien to acquire Alexandra’s interest in the Trust, it could revoke the Trust and become owner of the property.

The Court then held that the Trust’s title policy claim was excluded from coverage by a standard policy exclusion for matters “created, suffered, assumed or agreed to by the insured claimant.”  Alexandra allowed the liens to exist, by her non-payment of taxes, and Alexandra, as trustee, “‘suffered’ the liens on the property by accepting title on behalf of the Trust.”

Under the circumstances, the Court said Stewart Title’s knowledge of the tax liens prior to issuing the owners policy makes no difference.

Moral:  There may be ways to shield assets from creditors by use of a trust (see, “spendthrift trust”), but this wasn’t one of them.  And protection against your own pre-existing debts is not ordinarily covered by insurance.

The (unpublished) case is reported as Murnan Spring Hill Trust v. Stewart Title Guaranty Company, 105 A.F.T.R.2d 2010-1756  (4th Cir. 2010).